How is homeowners insurance calculated?

Why are insurance policies and rates filed with the state?

Insurers are required to file any informed consent forms and insurance policy forms with the appropriate regulatory agency. The agency enforcing the regulation is the Department of Insurance (DOI).

Rating laws apply to property, liability, and automobile insurance. The various rating rules that determine how much an insurer charges for insurance fall into one of the following categories:

1. Prior approval is problematic for most insurance companies. Insurers are generally required to obtain permission from the DOI for rate changes before they can change it, and reason must be given for the difference. Under most states' regulations, the rate change is deemed approved if no objection is submitted within a specified period, such as 30 or 60 days.
2. File and use are when insurers don't need to wait for approval from the DOI before changing their rates.
3. Use and file are when insurance companies can change rates immediately but must file a new rate with the DOI within a specified time.
4. Open competition is a law that allows the elimination of all filing requirements. Insurers are not required to file rate schedules with the DOI. Rates set under this law are naturally regulated by competition.

How do home insurance companies decide their rates?

Insurers set a premium that is proportional to their risk of loss. The premium charged for each insured should be sufficient for insurers to cover the losses and expenses of the group of similar insureds. Additionally, there must be some profit for the insurance company. How do insurance companies get billed? First, they need to determine the applicant's exposure level. By way of example, if you do not have homeowner's insurance and live in a home valued at $500,000, you will have a risk of $500,000. After the insurer determines a premium, it then applies a rate to the exposure units. The price made will be based on the cost per unit of exposure. An exposure unit is a unit used in measuring insurance loss.

The appropriate exposure unit typically depends on the type of insurance. Each $100 provides $100 of coverage for property insurance—each month (one car insured for one year would be 12 exposure units). Calculating the premium is based on how much the rate is multiplied by the number of exposures.

For example, the property insurance premium for a homeowner with a $500,000 property insurance policy at a rate of $0.25 per $100 of insurance is $1,250.

Premium = $500,000.

A price of $100(5,000 units × $0.25 per unit)

When the underwriter needs to release an insurance policy, they determine the premium based on the risk. Rates change on (a variety of different factors)

There are three prominent types of ratings.

1. Tolerance rating

Rates are determined according to an underwriter's expertise and not by an actual premium manual.

2. Individual or Class rating

All state rates are contained in the insurance company's manual. Manual ratings may be altered by either merit or experience rating.

Under experience rating, the premium is weighted more heavily for people who have been involved in more claims already. If past loss experience exceeds what is expected of similar class members, the insured will pay more than the manual premium. Insurers pay for the insured's past loss experience, which reduces the amount that the insured pays.

Under the retroactive rating, the insurance premium increases during the policy period based on the amount of loss incurred. The final premium is determined by a formula based on the insured's actual loss experience during the policy term, sometimes subject to a minimum and maximum premium.

3. Merit rating.

With merit rating, those more likely to have losses pay more in merit rating while those less likely to have losses pay less. With auto insurance, one with a clean driving record is expected to receive a lower premium than someone who can't drive between the lines or constant speed.

What is the loss ratio?

Loss costs are a factor insurers use to help make their rate-setting decisions. It indicates the amount an insurer should collect to pay a claimant's claim.

Insurers use loss ratios to determine the profitability of a business. Insurers need to consider if the company can cover its losses through its current revenue stream. The loss ratios can be evaluated by the formula below. Losses divided by earned premium give a loss ratio. When dividing $100,000 by $200,000, 50% is the result. Loss ratios that are less than 100% indicate an insurer is making a profit. When the loss ratio exceeds 100%, profits suffered due to the loss ratio.